122
Although apartment construction has heated up in Minneapolis, renter demand remains healthy as many renters are wary of homeownership.
As a result, vacancy is still below market equilibrium. Many renters in the market are young professionals who, before the housing market collapse, would have been looking to purchase a condominium.
To appeal to renters, new apartment developments are adding higher-end finishes and features such as a concierge service, pub or cafe, outdoor gathering space, rooftop decks, dog runs and pet-care areas. In the process, builders have established a new rent ceiling and redefined the Class A segment.
Supply-Demand Balance
As a wave of new high-end projects are injected into the market, owners with existing top-tier properties could be at a disadvantage and will need to increase concessions to maintain occupancy levels.
Approximately 131 apartment units came on line in the second quarter, for a total of 405 units finalized in the first half of 2012, expanding overall inventory by 0.3 percent. In the first six months of last year, 175 units were added.
Development activity is expected to continue at a heightened pace. Some 2,450 units are under construction with completions scheduled through 2013. Also, there are more than 9,300 units planned.
West View Estates, located on Vicksburg Lane in Plymouth, was the largest project to come on line in the second quarter. The complex will increase inventory in the West submarket by 67 units. Class A supply is forecast to spike by 1,865 units in 2012, a 1.2 percent addition.
This will put upward pressure on vacancy as demand struggles to keep pace, especially in the Minneapolis submarket, where half of the new inventory will be located. Last year, just 477 rentals were completed.
Strong renter demand has reduced vacancy 20 basis points year to date through the second quarter to a very tight 2.4 percent, despite a rise in inventory.
Vacancy contracted 10 basis points during the second quarter. Class A vacancy held steady at 3.4 percent in the second quarter as renter demand kept pace with supply additions.
Vacancy in top-tier properties has fallen 30 basis points so far this year. In the first half of 2012, the vacancy rate at lower-tier properties dropped 50 basis points to 1.6 percent and is down 100 basis points over the past four quarters.
A spike in inventory during the second half of 2012 will outpace renter demand, increasing overall vacancy 30 basis points to 2.9 percent. Last year, vacancy retreated 120 basis points.
Average asking rents have climbed 2.4 percent in the past year to $972 per month, including a 1.5 percent bump in the first half of 2012.
Effective rents, meanwhile, spiked 3.8 percent year- over-year to $930 per month. Rents have risen in all submarkets during the past year. Class A asking rents increased by 1.1 percent to $1,155 per month in the first half of 2012.
Tight occupancy in the lower tier pushed asking rents up 1.7 percent to $825 per month. Improving occupancy has compressed average concessions offered by four days of free rent in the first six months of the year, driving revenues up 4.3 percent year over year.
Low vacancy this year will enable operators to record the highest annual asking rent increase since 2008, as asking and effective rents advance 3.1 percent to $988 per month and $934 per month, respectively.
Investment Sales Outlook
Stronger apartment operations and buyer interest should motivate additional owners to list properties during the reminder of the year ahead of a potential rise in taxes and interest rates. Quality inventory remains scarce, as improving revenues have kept sellers on the sidelines.
Recent gains in transaction prices and the potential rise in the capital gains tax next year, however, should bring more owners to the table before the end of the year.
Buyers are plentiful as the robust rental market is attracting many new investors and syndicates seeking to partake in the growing returns. Demand is especially high for Class A and B properties in good locations with large rent growth potential.
Initial yields for these assets range from approximately 4.75 percent to 5.25 percent for top-tier properties, while Class B properties sell at cap rates in the low- to mid-7 percent range.
Outbid on many of these transactions, some knowledgeable local buyers are looking for value-add plays while financing is abundant. Investor interest is slow to trickle down to the Class C market where cap rates remain above 8 percent.
— Adam Schlosser is the regional manager of the Minneapolis office of Marcus & Millichap Real Estate Investment Services.